UK employers review bonus schemes ahead of compensation cap removal

Employers are reviewing bonus and incentive arrangements ahead of the removal of the statutory cap on unfair dismissal compensation. Commencement regulations made on 26 May under the Employment Rights Act have confirmed that the statutory cap on unfair dismissal compensation – currently the lower of one year's pay and approximately £120,000 – will be removed from 1 January 2027, prompting many firms to review remuneration structures ahead of the change. 

The practical effect of the change is striking – For senior, highly paid individuals, the potential value of unfair dismissal claims could be significantly higher than under the current regime. Bonuses, share awards and other incentive arrangements could play a much bigger role in senior executive disputes, both when claims are brought and when settlement terms are negotiated. That raises an important question for employers. If incentive arrangements are likely to come under greater scrutiny, are bonus schemes and the processes used to operate them robust enough to withstand challenge? We’ll speak to employment lawyer Chris Evans about some of the common causes of bonus disputes and the practical steps employers can take to reduce the risk of costly claims.

One concern is that bonus schemes are often longstanding and may not have been reviewed for some time. If the rules are unclear, or the way a scheme operates in practice differs from the written terms, disputes can arise, particularly when an employee leaves the business. And there’s the importance of process. Where managers exercise discretion over bonus awards, employers should be able to demonstrate that decisions were reached fairly, consistently and for clear business reasons. A well-documented decision making process and appropriate oversight can be important safeguards if a decision is later challenged.

So, let’s get a view on this. Chris Evans has been advising clients on these issues and earlier he joined me by phone from the London office to discuss it: 

Chris Evans: “What we often see with bonus schemes is that they either very historic or haven't been looked out for a while and most years there isn't a problem because it's a very good thing the staff are given bonuses but in circumstances where there either are bonuses not being paid out, or bonuses are less than employees expect, that's very often where we see the challenge and what we're looking to do is to pre-empt those challenges by ensuring that employer’s bonus schemes, and the processes they follow through to implement them, are fit for purpose and they're going to send the best possible chance of defending any such claim if one arises.”

Joe Glavina: “Problems arise around discretionary bonuses when people didn’t get the pay-outs they were expecting. It can be very costly for the employer if they get it wrong, can’t it Chris?”

Chris Evans: “Absolutely, so the costs of getting the bonus scheme wrong, or the implementation wrong, can be extremely high for an employer. One example is a case I did relatively recently was there was a dispute with an employee who was exiting as to the amount of the bonus and the bonus schemes rules were drafted in such a way that there was a level of ambiguity. The ambiguity meant that this individual was able to come to a figure which exceeded a million pounds whereas on our interpretation of the bonus scheme it was far less, around the £100,000 mark. So, you could end up in a situation because of the value of the claim, particularly that claim, where you could end up in the High Court and the legal fees alone associated with that would run into the tens, if not hundreds of thousands of pounds. So, what we are looking to do here is try and ensure that the bonus scheme is fit for purpose so that when you are presented with a challenge like that you can clearly turn around and say no, the bonus rules are clear, there's an element of discretion here, yes, but we're not acting irrationally when exercising that discretion.”

Joe Glavina: “I can imagine some managers struggling with that. So, they might see a decision not to pay a bonus, or to pay a lesser amount, as perfectly rational, but the employee, and perhaps ultimately a court, might see it differently. What’s your message to HR on handling that?” 

Chris Evans: “Yes, I think what is a helpful takeaway for employers is that if you are paying some bonus, and there's an element of true discretion if I can put it that way, so you're not fettered by the contract as to what you can and can't take into account, and you apply the appropriate categories as part of your discretion, as part of your decision making, then a court should be reticent to interfere and there is good case law authority which goes to that. The difficulty, however, which I say is that you very often have ancillary claims associated with a bonus dispute. So there may be a discrimination claim or there may be a whistleblowing complaint, for example, and what we typically see is that an individual will claim that the manager who made the decision about the bonus has subjected them to some form of discriminatory treatment, for example, and that give rise to a significant concern because if they are the ones making that decision, and if there is a finding of discrimination, a court would be quite alive to the fact that actually any discretion which has been exercised could be irrational in circumstances where the decision maker is found to be discriminatory. Now, this is always why I recommend there to be at least a review process as part of a bonus decision making exercise. So even if the manager identifies what bonus they think it's appropriate they should document why, first of all, so we've got an audit trail, but that needs to be independently audited by another manager. So at least then if we get into a dispute, we can say, well, yes, you may have a complaint against your manager for discrimination, or for whistleblowing detriment or whatever it may be, but the exercise of discretion around the bonus has been independently verified and the second manager has not been tainted, even on your own account, by this alleged discrimination. So again, it just gives us more ammunition to go into litigation, if indeed it arises, so that we can properly defend these claims.”

So, the key takeaway is that with the removal of the statutory cap on unfair dismissal compensation now on the horizon, employers may want to take a fresh look at their bonus and incentive arrangements. As Chris explained, disputes can arise where scheme rules are unclear or where discretionary decisions cannot easily be justified, particularly when senior employees leave the business.

If you would like help reviewing your bonus arrangements and assessing potential areas of risk please do contact Chris – his details are there on the screen for you.